Claims 3-year turnaround is on track

Long-troubled telecom equipment maker Alcatel-Lucent sparked investor hopes it had turned a corner when it kept an ambitious free cash flow target and reassured on its 2011 profitability.

Shares in the Franco-American group shot up more than 13 percent to their highest level since October 2009, making it the French CAC 40 index's biggest gainer on Thursday.

Chief Executive Ben Verwaayen, a Dutchman who formerly led BT Group before taking over Alcatel-Lucent in September 2008, said the results showed that the group was on track to complete his promised three-year turnaround.

"We had the best profits this quarter since the merger and it's a clear indication that we are on our way to becoming a normal company going into 2011", he said in a call with reporters on Thursday.

Verwaayen was brought in to rescue Alcatel-Lucent, which competes with larger rivals Ericsson of Sweden and China's Huawei, and restore it to profitability after it was rocked by a value-destroying merger in 2006.

But the economic downturn led telecom operators to slash spending and last year's results were hit by a shortage of components that weighed on profits.

Alcatel-Lucent set an adjusted operating margin target of 5 percent of 2011 sales, the lower end of the 5 to 9 percent range that it has previously told investors it would hit in 2011.

Asked whether the 9 percent was now out of reach, Verwaayen said he did not exclude it.

"There is clear momentum in the market and for us as a company," said Verwaayen. "We feel confident that we will grow faster than our addressable market and aim at a significant increase in profitability."

Investors hailed the forecast-beating fourth quarter and signs that the fixed-line business was taking off again. Analysts from CA Cheuvereux and WestLB raised their recommendations on the shares, while Credit Suisse and Goldman Sachs said they were reviewing their estimates.

"We think the company now appears much more credible as a restructuring play, which should profit from market growth this year," wrote Thomas Langer of WestLB in a note.

GROWTH AHEAD

Alcatel-Lucent said the global market for telecom gear would grow in the high end of the previously predicted 0 to 5 percent range this year.

Market research firms have forecast 1.6 to 2.5 percent growth in telecom operators capital spending this year, as a boom in smartphones and tablets overload networks with data.

Alcatel-Lucent's full-year revenues for 2010 were up 5.5 percent to 15.996 billion euro ($21.90 billion), while its adjusted operating income was 288 million euro.

Analysts had expected 2010 revenues would be up 3.8 percent to 15.74 billion euro.

The group had an adjusted operating margin of 1.8 percent in 2010, the lower end of a 1 to 5 percent range for which it was aiming.

The fourth quarter brought a 22 percent increase in revenues, boosted by strong sales in North America. The group's adjusted operating margin for the fourth quarter was 8.1 percent of sales.

Alcatel-Lucent earns about one third of its revenues in the region through big contracts with AT&T and Verizon.

U.S. operators are investing heavily in fourth-generation wireless rollouts to cope with an explosion in data traffic.

But Alcatel-Lucent struggled to convert higher sales last year in to strong cash flows because of troublesome shortage of electronic components that forced it to stockpile parts.

As a result, it did not deliver on its pledge to break even on a free cash flow basis this year. Instead, it saw negative free cash flow of 818 million euros, according to Chief Financial Officer Paul Tufano.

"We increased our inventory dramatically as we suffered from component shortages," he explained. "But we plan to keep reducing inventory this year, and still aim for positive free cash flow in 2011."

Signalling some improvement, free cash flow in the fourth quarter was positive 319 million euros.